Advantages and disadvantages of raising the minimum wage

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After years of policies of fiscal austerity and liberalization of the labor market, most European countries are now betting on raising the minimum wage to regain the purchasing power of workers. In this way, it seeks to promote domestic consumption and thus strengthen the economic recovery.

In recent years, the upward revision of the SMI (Minimum Interprofessional Salary) seems to be a constant in almost all of Europe. If in 2015 the British government announced an increase in the minimum wage of workers of more than a thousand euros (up to the current € 1,378), other countries such as France, Belgium and the Netherlands have also made progress in this regard despite the fact that the European economy it is in danger of deflation.

The trend is particularly strong in Eastern Europe, where the increase in the SMI compared to 2007 reaches even greater proportions in Latvia (178%), Romania (143%) and Bulgaria (125%). It should be remembered that last year even Germany, which until then championed labor flexibility policies in Europe, has joined by establishing for the first time a minimum wage of about 1,440 euros per month.

In Spain, the Government announced an increase in the SMI of 8% for the year 2017 and most of the political forces have been in favor of following the European trend, although some require even greater increases. Now, in 2019 it announced a rise of 22% and more increases are expected for 2020.

Advantages of raising the minimum wage

In this sense, SMI supporters argue that an upward revision would lead to an increase in domestic consumption through a double effect: on the one hand, increasing workers' nominal income would improve their purchasing power; On the other hand, a redistribution of income towards the most disadvantaged sectors would boost spending due to the higher marginal propensity to consume of these groups.

Thus, an increase in the SMI would strengthen aggregate demand via domestic consumption, and therefore would reinforce the recovery of production and employment.

In the same way, they argue that a higher SMI would also have important redistributive effects without the need for any fiscal effort. According to this analysis, the resources allocated by the companies to cover the salary increase are subtracted from the corporate profits. This means that the lowest paid workers would go on to receive an income that would otherwise go to the owners, who usually enjoy a higher level of income. In this way, an increase in the SMI would contribute to reducing social inequalities without the need to resort to public spending, as is the case with many social policies for this purpose.

Finally, SMI defenders affirm that the existence of a minimum wage is an effective instrument in the fight against labor exploitation, since it reinforces the position of workers who would otherwise have difficulties when negotiating their wages. At the same time, a higher SMI would help increase human capital formation and reduce temporary employment, as employers are often more open to investing in higher-paid workers in the long term.

Disadvantages of raising the minimum wage

However, the SMI is also open to less positive analysis. In the first place, its detractors point out that the effect on consumption would only take place in the short term, since the increased cost of labor would end up being transferred to prices (generating inflation) and workers would lose the purchasing power that they would have gained. In the first moment.

Thereafter, domestic consumption could only improve slightly thanks to the monetary illusion, and the authorities should take measures to avoid falling into a vicious circle of inflation and wage revisions.

On the other hand, the redistributive effects of the SMI are not clear either, since its defenders assume that a higher minimum wage reduces business profits that would otherwise pass into the hands of owners with a higher income level. However, they forget that on many occasions these profits are reinvested in the company (improving the conditions of the workers themselves) and that frequently many of the shareholders are actually people of medium and even low income. In addition, the inflation generated by a higher SMI could reduce the purchasing power of low-income sectors that depend on fixed benefits, such as pensioners or the unemployed who survive thanks to public aid.

Inflation generated by a higher SMI could reduce the purchasing power of low-income sectors that depend on fixed benefits.

Additionally, it can be argued that an SMI that is too high can have a detrimental effect on unemployment, as it could drive the lowest paid workers out of the labor market. This means, for example, that a minimum wage of 1,000 euros would prevent access to a job to all those who cannot demand that amount for their work, simply because it contributes a lower value to the company. For this reason, on many occasions (especially in less developed countries) increases in the SMI that do not follow the evolution of real productivity only end up promoting black work, and have little impact on the lives of workers. So the minimum wage may end up harming precisely those it is intended to help.

In the theoretical framework, if the minimum wage is above the equilibrium point between supply and demand in the labor market, there will be a loss of employment. If it is below, it will have no effect on employment. The difficult thing is to know where that balance is.

The SMI in Europe

As for the old continent, characterized until recently by labor flexibility, the SMI now seems to be on the rise in almost all countries. Its effects on employment, however, are disparate and do not appear to present any clear pattern.

EU countriesSMISMI increase (nominal)SMI increase (real)Unemployment increase
Luxembourg1.922,96 €28%6%2%
Belgium1.501,82 €22%3%0%
Netherlands1.501,80 €18%2%2%
Ireland1.461,85 €13%4%5%
France1.457,52 €20%5%2%
Germany1.440,00 €0%-15%-6%
United Kingdom1.378,87 €14%-11%0%
Slovenia790,73 €54%33%3%
Spain756,70 €20%2%14%
malt720,46 €23%3%-1%
Greece683,76 €-4%-21%16%
Portugal589,17 €31%15%4%
Poland409,53 €76%53%-6%
Croatia395,61 €0%-23%5%
Estonia390,00 €103%66%0%
Slovakia380,00 €109%88%-2%
Latvia360,00 €178%137%3%
Hungary332,76 €35%-3%-1%
Czech Republic331,71 €27%6%-2%
Lithuania300,00 €88%54%3%
Romania217,50 €143%98%0%
Bulgaria184,07 €125%89%0%
Denmark2%
Italy5%
Cyprus10%
Austria0%
Finland2%
Sweden0%
Data from 2015 for minimum wages and comparison with 2007 for growth. Evolution of real wages discounting the annual IPCA accumulated in each country. Source: Eurostat.

Among the most successful countries are Poland, Hungary, Slovakia and the Czech Republic, which have managed to reduce their unemployment and raise the minimum wage. Betting on a model based on export-oriented industry and the development of their internal markets, the modernization of their economies has allowed them to increase the productivity of their workers and thanks to this they have been able to face a continuous increase in minimum wages, generating a virtuous circle between consumption and production.

On the opposite side we find countries such as Portugal, Latvia and Lithuania, which have also opted to raise the minimum wage, but have suffered at the same time an alarming growth in unemployment. Finally, it is also worth mentioning some cases of freezing the minimum wage (Croatia) or its reduction (Greece), although none of them seems to have been able to generate employment by itself.

In any case, the truth is that the SMI is undoubtedly one of the keys to the current European economic debate. Although it is true that its real scope is limited (since in many cases minimum wages are established by the collective agreements of each sector), it is important as a reference for working conditions in a country. As we have already commented, opinions are divided between those who seek to make the labor market more flexible and direct efforts to improve productivity (assuming that this will push up real wages) and those who seek to strengthen the SMI to promote consumption. Regardless of ideological evaluations, in reality the substantive debate about increasing the income of a country by acting on supply or demand: a dilemma as old as the economy itself.

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